Memories of banking crises die hard. Yet Europe’s major lenders enter the current tumult with significantly bigger shock absorbers than during the last meltdown. According to a Breakingviews calculator, they should have enough capital to weather a 2009-style bad debt spike almost three times over.
Banks are under pressure from all sides. Large clients have drawn down credit lines, while governments want lenders to help consumers and small firms. That means higher risk-weighted assets. Top-line income is taking a hit from sub-zero interest rates and payment holidays for customers. And troubled borrowers mean higher bad-debt charges.
Investors are worried, having on average wiped 41% off the market value of the 25 biggest European lenders. The fear is that depleted capital ratios will once again force banks to issue equity, or even seek government bailouts.
That’s too pessimistic. The 25 biggest banks, from UK-based giant HSBC, to Austria’s Erste, ended 2019 with common equity Tier 1 capital, on average, equivalent to 14.3% of risk-weighted assets. That’s roughly 4 percentage points above the average minimum ratio, after factoring in some of the relief granted by supervisors. Most banks have also conserved cash by postponing dividend payments.
Say that risk-weighted assets jump by 10% this year, close to the level experienced by U.S. banks at the end of the first quarter. Next assume that 2020 profit, before bad debt charges, falls by 10%. In that scenario, the average bank would have a buffer of spare capital equivalent to 4.1% of total lending at the end of 2019. That’s enough to withstand a huge surge in bad debt – almost three times the 1.4% of loans that the average European bank wrote off in 2009.
The average figures mark a wide dispersion, though. Losses equivalent to 1.9% of its loan book could force Deutsche Bank to dip into its so-called capital conservation buffer, where regulators can force lenders to suspend cash distributions or sell assets. Natixis could weather an 8.5% hit before finding itself in the same position, mostly because the French bank has a relatively small lending book.
But even in a more severe scenario, where RWAs rise by a fifth and pre-provision profit falls by the same proportion, all banks except Deutsche would still have a capital buffer equivalent to more than 1.4% of their loan books. European banks’ pain threshold is reassuringly high.